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Go Long Mylan Inc. (MYL) And Hedge With A Covered Call

|Includes: Mylan Inc (MYL)

11/04/2013 Covered Call Pick: Mylan Inc (NASDAQ:MYL)

Mylan Inc. (MYL) develops and manufactures generic and branded drugs for the treatment of central nervous system, cardiovascular, and other disorders. Mylan Inc., through a recent acquisition of the India-based Matrix Laboratories Limited and the German-based Merck KGaA generic business, has become the world's fourth-largest generic and specialty pharmaceutical company with approximately 19,000 employees, that help produce more than 1,000 separate products, that help serve over 150 countries and territories around the world.

Mylan Inc has a market capitalization of $14.51 billion with 381.8 million outstanding shares.

Mylan currently pays no quarterly dividend.

With a beta of 0.81, MYL currently trades with approximately 80% of the current market's volatility.

As one of the largest generic pharmaceutical companies in the world, Mylan has been able to not only profit from the patent cliff of high value drugs such as Diovan, Actos, and Lexapro in 2012, but also from economies of scale, as Mylan has one of the largest and most efficient scales of vertical integration manufacturing in the world with one of the cleanest operating histories in the industry. This has led to steadily increasing earnings since 2008 and expected EPS increases of 11% in 2013 and 17% in 2014.

Despite the steadily increase in earnings, Mylan's revenue has been sluggish. Last quarter they reported a 2% decrease in revenue (unchanged if you exclude currency effects) with a slight decrease in yoy non-GAAP EPS. The revenue decline is due to a 14% decline in North American generic sales, despite significant growth in the Europe and Asian-Pacific regions sales (6% and 13% respectively). Despite the revenue decline in generics, Mylan's specialty segment increased by 18%. At approximately 15% of revenue, the specialty segment consists of almost entirely their EpiPen product, which continues to witness significant volume and pricing strength increases.

We expect Mylan's emerging market growth to continue to be a great driver for revenue growth in the future, as the generic drug market for the developing world still has not been fully tapped. We also believe that year-over-year comparison in North American sales to pick up in 2014, due to a number of generic versions of blockbuster drugs they have the capability to release. These namely include a generic version of Copaxone, as well as Lidoderm, and the blockbuster asthma drug, Advair.

This does not mean the company is without headwinds. European government-mandated price cuts, the end of the U.S. patent cliff, and the potential for a generic launch of Mylan's EpiPen in 2015, which constitutes one of their only branded products, all pose some significant obstacles for the company. That said, as the price of medicine continues to rise around the world, it becomes more and more feasible that generic versions of pharmaceuticals to become more favorable as compared to high-priced name branded drugs. We believe Mylan has the capability to create sufficient biosimilars to these name-branded drugs, while additionally developing more of their own branded products, a capability they have yet to sufficiently test.

In the near term though, we cannot ignore the facts before us. While the stock's Up/Down ratio is a strong 1.5, and its Accumulation/Distribution Ratio remains positive at B-, with the number of funds that hold the stock increasing by 13% over the last three quarters, the stock is breaking down technically. These ratios will help provide support for the stock, as well as its relatively cheap valuation with a P/E of 14 (in a market where stocks are getting more and more expensive on an earnings valuation basis) which will attract value buyers in the market. For our Covered Call Strategy we want to protect our cost basis in light of these headwinds and technical pressure, so we want to sell an at-the-money Call. This will allow us to pick up a decent premium to offset the fact that the stock doesn't pay out any dividend, while protecting us from the technical pressure the stock is currently under. That is why we are recommending buying MYL and selling the April 2014 $39 Call.

Scenario:
 

  • Buy 100 shares of MYL @ $38.75 = $3,875 + Commission ($12.95) = $3,887.95
  • Write 1 MYL April 2014 $39 Call @ $2.23 - Commission ($8.70) = $214.30

Note: Prices may vary from the time of post. Actual commissions paid will vary returns.


Static Return (Not Called):
(Call + Dividend)/Stock Price X (Days/Year)/Days to Expiration

(2.14)/38.88 X (365)/164

= 12.25% Static Return


If-Called Return:
(Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration

(2.14 + 39 - 38.88)/38.88 X (365)/164

= 12.94% If-Called Return


Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarentee the above, or any, result. All investment decisions should be made based upon individual's personal investment goals and risk tolerance.

Posted by OaktreeAdvisors at 11/4/2013 10:58 AM
Categories: Weekly Picks

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Disclosure: I am long MYL.

Additional disclosure: As active managers we will buy and sell as need and as suitable for our clients.